01.07.2020
Acid test or quick ratio
Usually, any professional linked to the business world needs to analyze the financial statements of a company.
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Sanz González , María Acid test? But what is this all about?
This analysis is usually done using metrics. The objective is to be able to measure the evolution of a company through the financial statements.
Among these metrics we find the so-called financial ratios. Ratios are quantified relationships of two or more magnitudes. They are generally taken from the balance sheet and the profit and loss statement.
The ratios referred to are usually divided into the following categories: liquidity, management, solvency and profitability. In this collaboration we will focus on the so-called liquidity ratios.
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Liquidity ratios
The term liquidity refers to a company’s ability to meet its financial obligations. That is, the ability to obtain cash to pay its short-term commitments.
Liquidity ratios are a set of indicators that show whether a company is capable of generating cash flow. That is, if it is able to convert its assets into liquidity.
These indicators use, for their calculation, magnitudes extracted from the balance sheet. Specifically from the so-called current assets and current liabilities.
Current assets contain the assets of the company that are liquid (cash) or can be converted to cash in a short period of time (customers, stocks, etc).
On the other hand, current liabilities are all those items that include debts that mature in less than a year.
Within this category of ratios we can find different indicators. For example, the general liquidity ratio or current ratio. This ratio measures the proportion of short-term debts covered by current assets.
It is calculated by dividing current assets by current liabilities.
This ratio indicates how many euros the company has, as current assets, on each euro it has of short-term debt. Therefore, if the indicator reflects a number lower than one, it will be necessary to analyse what is happening. Because a priori there will be more debt than assets to pay it.
On the other hand, there are the so-called accounts receivable ratios, i.e. about its receivables.
They are calculated by dividing the receivables by the annual sales, multiplied by the number of days in the year.
This ratio reflects the average period in which these accounts will be converted into cash.
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What does (materiality) mean in terms of (financial statements)?
Acid test
The acid test (quick ratio) is linked to the company’s ability to meet its payment obligations. In this case, this ratio is much more demanding than the so-called current ratio.
It is calculated by dividing current assets by current liabilities. Inventories are removed from current assets.
In other words, the denominator of this ratio is made up of customer items, temporary financial investments and cash. The entire inventory of the company is excluded. This is why it is more rigorous, as it only computes the assets that are most easily converted into cash by a company.
As with the current ratio, this indicator is interpreted positively, provided it is above one.
Liquidity and solvency
A company’s liquidity and solvency are two closely related indicators.
Liquidity, as we have indicated, is the ability of business assets to be converted into cash. Ability to pay immediate obligations.
Solvency, on the other hand, is the capacity of the company to meet its payments. Both in the short and long term. Solvency relates to the total assets and liabilities of the company. It indicates how many resources a company’s assets have compared to its liabilities.
Every company must seek a balance between both ratios. That is to say, to have the capacity to make cash, and to be able to meet short-term payment obligations. However, we must bear in mind that a lack of liquidity does not necessarily mean a lack of solvency.
Conclusions
The study of companies through ratios is a very common technique for analysts. It allows knowing immediately the economic situation of a company.
The liquidity ratios analyzed allow managers and analysts to check the capacity to generate cash flow. In order to control their immediate payment commitments.
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